I expect stocks to have a good year, but 16.7% in returns is probably unlikely. It’s also wort...
Cash "Flow" at Digital River
11/11/2005 12:00 am EST
"Among the more than 100 variables used in our Quadrix stock-rating system, none has done a better job of picking winners than the price to free cash flow ratio," says Richard Moroney. Here, the editor of Upside, looks at one cash flow favorite, Digital River.
"With software increasingly delivered via Internet downloads, the impressive growth at Digital River (DRIV NASDAQ) should continue. The company, a provider of online commerce solutions, has delivered at least 30% sales growth in each of the last four years. Per-share earnings have risen sharply since Digital River turned profitable in 2003, with at least 37% year-to-year growth for six straight quarters. Per-share profits should be up 60% to 70% for full-year 2005, and growth of 15% to 25% seems likely in 2006. The stock, reasonably valued at 16 times expected year-ahead operating earnings, is a Best Buy.
"Digital River provides a wide range of services for e-commerce, including site development and hosting, catalog and pricing management, transaction processing, product delivery, and customer service. By outsourcing these functions, companies free up time and resources to focus on core businesses. Digital River’s customer base of more than 40,000 includes Motorola, H&R Block, and Staples.com. Symantec, a maker of security software, is Digital River’s largest client, accounting for about 38% of 2004 sales.
"The software industry is transitioning from not only selling products online but also delivering them through digital downloads. Electronic software distribution (ESD) accounted for 1% of global software sales in 2004, but that number could reach 10% in five years. Anti-virus software makers, including Symantec, were among the first to adopt downloadable distribution, and security software sold through this method considerably outpaces packaged-software sales.
"Software clients distribute their online ESD product catalog through Digital River’s network of more than 50,000 affiliated online retailers, content sites, and portals. To drive user traffic and sales, Digital River provides its affiliates with sales incentives and marketing tools. For example, video-game software publishers can sell titles through Digital River’s catalog of more than 500 downloadable games. The catalog is then offered to online merchants such as Best Buy and Circuit City.
"Management expects international sales to represent 60% of total revenue by 2010, up from 39% in the June quarter. Japan, China, Russia, and Latin America are areas of focus. Digital River conducts sales and customer service in 11 languages, runs Web sites in 17 languages, and offers payment options in 26 languages. Management places importance on creating e-commerce offerings that appeal to different cultures, hiring local personnel who understand the expectations of local customers.
"Digital River ended the June quarter with $322 million (about $7.85 per share) in cash and investments. The company repurchased $3.2 million in shares in the June quarter. Consensus profit estimates for Digital River, which exclude the impact of acquisition-related expenses, project per-share earnings of $2.01 for 2005 and $2.39 for 2006. At 14 times the 2006 estimate, the stock trades at a big discount to its peer group. The stock earns a Quadrix Overall score of 93, with high marks in Quality, Momentum, and Financial Strength.
"Overall, Digital River had cash from operations of nearly $99 million—more than double its net income. After capital expenditures of $11 million, and no dividends, free cash flow totaled $88 million, or $2.62 per share. Dividing $2.62 into the stock price results in a price/free-cash-flow ratio of 13—lower than that of about 78% of US companies. Historically, buying stocks with low price to cash flow ratios has been a winning strategy. Since 1994, among all variables used in Quadrix, this ratio has been the single best metric for picking winners."
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